Question

Warrants Srorm Software wants to issue $90 million ($900 x 100,000 bonds) in new capital to fund new opportunities. If Storm raised the $90 million of new capital in a straight-debt 20-year bond offering, Storm would have to offer an annual coupon rate of 13%. However, Storm's advisers have suggested a 20-year bond offering with warrants. According to the advisers, Storm could issue 11% annual coupon-bearing debt with 24 warrants per $900 face value bond. Storm has 10 million shares of stock outstanding at a current price of $20. The warrants can be exercised in 10 years (on December 31, 2025) at an exercise price of $25. Each warrant entitles its holder to buy one share of Storm Software stock. After issuing the bonds with warrants, Storm's operations and investments are expected to grow at a constant rate of 12.6% per year. If investors pay $900 for each bond, what is the value of each warrant attached to the bond issue? Round your answer to the nearest cent. $ What is the component cost of these bonds with warrants? Round your answer to two decimal places. % What premium is associated with the warrants? Round your answer to two decimal places. %

Answer 1

1. Warrants give the holder a right to exercise at expiration.

Here storm software has two choices to raise debt

a. 20-year bonds at 13% priced at $900 and par value =$900

Since the face value is equal to the value of the bond that means bonds have been issued at par so interest rate = 13%.

b. 20 years bonds with attached warrants

Using the interest rate calculated in the above step, and coupon rate = 11%, we can calculate the price of the bond attached with a warrant.

The interest rate =13% is used as a discount factor.

coupon payment = 11% *$900 = $99

total Price of the bond attached with warrant =

+ Face value / (1 + discount rate)²⁰

^{The price comes out to be $773.55}

^{Hence value of each warrant attached with bond = ($900- $773.55) / 24 = $ 126.45 / 24 = $ 5.27}

^{2. Component cost of the bonds attached with warrants}

^{Value of bonds attached with warrants = Bonds without warrant - value of warrants}

^{= $900- $126.45 = $773.55}

3. Warrant premium = (Warrant price +exercise price - current price)*100 / current price

= ($5.27 + $25 - $20) *100 / $ 20

Warrant premium = 51.34 %